The more you learn about personal finance, the more complicated your questions are likely to get. But never fear: Hosts Robert Brokamp and Alison Southwick named their podcast Motley Fool Answers for a reason, and the Oct. 29 episode -- the monthly mailbag show -- the co hosts will tackle a whole bunch of money conundrums with a bit of help from Motley Fool Wealth Management Director of Financial Planning Megan Brinsfield, CPA, CFP, and all-around fine human being.
In this segment, they reply to an email from Joe, who has absorbed the rule that you shouldn't put money in the stock market that you're going to need in the next five years -- because if you do, you might not have time to recover from a downturn. But that's for stocks and stock funds: What's the guideline when it comes to bond funds?
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This video was recorded on Oct. 29, 2019.
Alison Southwick: The next question comes from Joe. "You often mention the general rule of not investing money into the stock market that you need in the next five years, plus or minus, which I understand is based on roughly how long the stock market has typically taken to recover after a recession. Is there a similar guideline for bond investing? Assuming I'm investing in a bond fund rather than individual bonds, where I would know the exact maturation date of each investment, is there a rule of thumb for how long I should plan for it to stay in the bond fund? Thanks very much. Bonds!"
Robert Brokamp: He makes the important distinction that if you invest in an individual bond -- you invest $1,000 in a five-year bond -- you know in five years you'll get that $1,000 back as long as the issuer is still in business. Bond funds go up and down in value and you don't know what it's going to be worth in the future.
And they can lose money, except generally speaking, it's not very much. So when you look at the overall bond market, years when it's down we're talking like single digits. Since 1926, the worst year for the overall bond market was in 1969 and it was a drop of 8%, so not a big deal.
That said, it does depend on the type of bonds you own and the two important things to consider are interest rate risk and credit risk. Interest rate risk is more important. If you have a long-term bond and interest rates go up, you could see that bond fund go down 10%-15%. And then the other is credit. So if you have a high-yield bond fund -- otherwise known as a junk bond fund -- those can go down significantly. Most of those lost more than 20% in 2008. I generally recommend that you stay away from those.
If you're going to go with bond funds, any money you absolutely need in the next year or two should probably be kept in cash, short-term CDs, or something like that. Maybe even three years. Otherwise you're fine to have a bond fund. I generally think you should keep it in a safer bond fund: investment grade, corporates, or Treasuries, intermediate term, low cost, and you'll be fine.
